The Unexpected Costs of Sarbanes-Oxley

It's been a while since I beat up on Sarbanes Oxley, and it's a slow Friday. So, here we go again. Grant Thornton recently mailed out questionnaires to CFOs, treasurers, and controllers. Based on the 101 responses they received:

sixty-five percent of senior financial executives of public companies surveyed say it’s more difficult today to recruit corporate directors because of the three-year-old federal Sarbanes-Oxley corporate-disclosure law and concerns about higher director liability

....“Sarbanes-Oxley was a needed watershed event in corporate governance, but along with the greater protection of investors, there are increased time requirements for directors,” says Ed Nusbaum, Grant Thornton LLP chief executive officer. “But an even greater obstacle is the fear of litigation.”

In retrospect, it's not that surprising - if you increase the "cost" of an activity, you will generally see less of that activity.

Unfortunately, regulators tend to have a static view of the world. By this, I mean that they act as though they can change one part of the rules, and none of the "players" in the system will change their behavior.

Thomas Sowell has a great book that's based on this principle: "Applied Economics: Thinking Beyond Stage One". The title of the book is based on a class he took where the professor gave a scenario to the class and then asked the students what would happen. After Sowell's initial response, the prof then asked

"And THEN what would happen?".

Once Sowell answered this question, the proff then asked again,

"And THEN what would happen?".

It's a good lesson - or every time there's a change in the "rules"that affect the costs, or benefits associated with an action, the players in in the system will change their actions in response. Then, the players will change their actions in response to the players' initial canges, and so on.

Unfortunately, the regulators/politicians who made the initial rule change have often moved on before all the effects of the initial change are played out. Sarbanes himself is a perfect example - he's retiring this year, and we still have barely scratched the surface on the effects of SarbOx.